Canadian
federalism, the Tax Rental Agreements of the period of 1941-1962 and fiscal federalism
from 1962 to 1977

Claude Bélanger,
Department of History,
Marianopolis College

Simply
stated, the Tax Rental Agreements were a system by which the provincial governments
accepted to "rent", to give up, to the federal government the three
standard direct taxes (personal and corporate income taxes and succession duties)
for a limited period of time, in return for payment to each province of certain
fixed sums of money. The method to be used was reminiscent of the one suggested
by the Rowell-Sirois Commission.

The
occasion for the introduction of the Tax Renting System was the Second World War,
when it became necessary for the federal government to raise such a high level
of taxes for the conduct of the war. Had an agreement not been reached, it is
likely that the war effort would have been impeded and that provinces would have
found themselves incapable of supporting fully provincial services. However, it
would be difficult to consider that the war alone created such tax renting agreements:
the war merely precipitated an action that many in the poorer provinces, had been
demanding for a period of time.

The
true source of the Tax Renting Agreements is to be found, on the one end, in the
imbalance which developed in the period of 1920 to 1940 between the expenditures
of provinces and their capacity to levy taxes locally to meet such expenditures;
on the other end, the problem was magnified in some provinces, because of their
relative poverty and their inability to provide to their citizens services equivalent
to those offered by the richer provinces. Ultimately, the poorer provinces could
only offer such services by imposing larger than average taxes on their citizens,
thus lowering even further the standard of living of their local population. It
became socially unacceptable to Canadians, especially in English-speaking Canada,
that some citizens in the country, because they were born in a poorer region,
accept lower services than their counterparts in richer areas. It was apparent
that the more fortunate provinces would have to contribute financially to the
support of the have-not provinces. The role of the federal government would have
to be that of a funnel through which financial resources would be redistributed
across the country. This new ethic of canadianism was doubly justified
because many Canadians came to the realization that they had not shared equally
in the prosperity that Confederation was supposed to bring to all.

Prior
to the 1930's, provinces had often complained and managed to extract some concessions
from the federal government but always on the grounds that some promise at Confederation
had not been fulfilled or that the terms of the union had not been equitable enough.
What developed, in the 1930's, was an entirely different kind of argument. The
new position was well summarized by Norman McL. Rogers, before the Nova Scotia
Economic Inquiry in 1934: "It is urged that Nova Scotia is entitled to relief
and compensation, not merely in pursuance of the assurances given on the occasion
of its entrance into the Canadian federation, but also on the broad equitable
ground that a federation defeats its primary purpose, if through its constitutional
arrangements or through policies instituted by the national government it accomplishes
the gradual debilitation of one or more of the provincial communities of which
it is composed."

Thus, it was felt
in the poorer provinces that federal action was necessary: the more taxes would
be centralized in the hands of the federal government, the more that level of
government would be capable of helping financially the weaker provinces. Hence,
the suggestion of the Rowell-Sirois Commission for the provinces to turn over
their main direct taxes in return for National Adjustment Grants to be allocated
to the less fortunate provinces. Some of the provinces had rejected such a system
because it undermined provincial autonomy. The war rendered possible what even
the Great Depression had not achieved: the system of tax rental was thus introduced,
for the first time, in 1941.

1) Wartime
Tax Rental Agreement (1941-1947)

Under
the Wartime Tax Rental Agreement, the provinces withdrew from levying corporate
and personal income taxes and succession duties in return for annual rental payments.
The provinces had the choice between two possibilities:

a)
the revenue tax yield within the province in 1941 from the vacated tax fields,
or

b) the net cost of servicing the provincial
debt for the fiscal year 1940-41, less succession duties collected for that year.

Saskatchewan
and the Maritimes chose the second alternative while the other provinces elected
to take the first one. These arrangements were to be temporary, for the duration
of the war, and extend one year after the cessation of the hostilities. The taxes
were thus made uniform and the population of two provinces (N.B. and N.S.) paid
income taxes for the first time.

2) Tax
Rental Agreement of 1947-1952

At
the end of the war, it became obvious that the federal government was anxious
to maintain control over the important tax fields to combat the expected depression
after the war; at the Reconstruction Conference, the federal government proposed
that the provinces abandon permanently the direct taxes rented; that proposition
was eventually shelved, because of the opposition of some provinces, but Ottawa
worked out a new proposal which it presented to the provinces in 1947.

As
A. Maxwell wrote in 1948:

No
great perspicacy was required (...) to fore see that the forces that made for
Federal occupancy during the war would not be spent after the war, that tax payers
might wish to retain the luxury of one law and one return, and that those provincial
governments which received more by way of subsidies than from provincial collection
might prefer to continue the agreements.

Under
the agreement in 1947, the provinces would refrain from imposing the usual taxes
in return for rental payments. They could levy a corporation tax of 5% collected
by Ottawa that would be part of the federal rental payment. The provinces could
chose from two options:

a) $12.75 per
capita based on the 1942 population of the province; plus 50%of the revenue received
by the province from personal and corporation income taxes in the 1940-41 fiscal
year; plus statutory subsidies.

b) $15.00
per capita based on the 1947 population of the province; plus statutory subsidies.

Special
considerations were extended to P.E.I. which was offered $2,100 000. Option A
was selected by New Brunswick, Manitoba, Alberta and British Columbia; option
B was chosen by Nova Scotia and Saskatchewan. Two provinces (Ontario and Quebec)
expressed the wish to not enter into new agreements. For them the federal government
vacated a certain portion of the direct tax field that the two provinces could
then occupy. The federal government withdrew by 5% of the personal and corporate
income taxes and by 50% of succession duties. Both provinces introduced a 7% tax
on corporations but did not use the personal income tax cut. These arrangements
were far from equaling those that the other provinces had received; both provinces
were penalized for sticking to strict federalism, to provincial autonomy. It has
been estimated that Quebec lost $300 000 000 during this period (based on an average
yearly distribution the budget of the province of Quebec would have been increased
by 31% in 1948 and by 22% in 1952 had the province accepted the rental agreements).

3)
Tax Rental Agreement 1952-1957

In
return for the rental of the usual taxes, the provinces could choose one of the
following alternatives:

a)
a 50% increase in the 1947 per capita grant, under a formula based on the increase
in the population and gross national product between 1942 and 1948; plus statutory
subsidies.

b) 5% of the federal personal
income tax yield in the province in 1948; plus

the
yield of a tax of 82% on corporation profits in the province in 1948; plus

statutory
subsidies.

All the English-speaking provinces
signed, including Ontario, and Quebec found itself alone in the fight for the
autonomy of the provinces. The federal government granted to Quebec a 7% abatement
on corporation taxes and 5% on personal income tax. However, in 1954, Maurice
Duplessis introduced a provincial income tax scheme equal to 15% of the federal
rate to which Ottawa responded by a l0% abatement. The Prime Minister of Canada,
Louis St-Laurent, declared that the federal government would not yield any further
abatements. Thus, the people of Quebec were threatened by double taxation because
of federal initial inflexibility. The population of Quebec obviously supported
its provincial government and, eventually, the federal government granted the
full abatement. Despite these arrangements, the province was again heavily penalized
as can be gathered in the following statistics:

Per
capita payments to the provinces under the 1952-57 tax scheme

1952-53

1954-55

1956-57

Canada less Quebec

$30.50

$32.50

$34.00

Quebec (abatements)

$27.76

$29.90

$31.06

4)
Tax Rental Agreement of 1957-1962

The
same rental system was continued except that the compensation took the form of
a percentage of the revenues collected from the rented taxes. Quebec continued
to be the only province collecting its own taxes fully. The provinces received
only one option: 10% of personal income taxes collected in the province; 9% of
corporation profits and 50% of succession duties collected in the province. Since
that system disadvantaged the poorer provinces because their tax yield, on an
equal percentage, was not as great as that of the wealthier provinces, the federal
government introduced the equalization payments (unconditional grants) which were
equal to the amount necessary to bring the level of the per capita yield of the
three standard taxes in each province to the average yield in the provinces of
Ontario and British Columbia. Under this system, Quebec was not penalized for
the first time since the introduction of the Tax Rental system, as it received
equalization payments from the federal government.

5)
The system since 1962 to 1977

The
tax renting system was drastically altered in 1962 to take roughly a form that
it was to keep until 1977 when block funding was introduced. Provinces did not
have to rent their three standard taxes anymore. Rather, a system of tax abatement
was instituted: the federal government would not collect 100 of the three standard
taxes but would leave some taxing room so provinces could raise their own taxes.
The taxing room vacated by the federal government was originally: 16% of personal
income tax to be increased by 1% per year; 9% of corporation profits; and 50%
of succession duties. These abatements have been continuously raised since to
meet rising provincial expenditures. Provinces could collect such taxes themselves
or have the federal government collect them; if the latter was chosen, the federal
government shoulders the cost of collecting the taxes and returns to the provinces
their share of the collected taxes. Provinces are also free to impose a higher
level of taxes than those stipulated. Quebec continued to collect all of its taxes
and to impose a higher level of taxes than the abatement given. Ontario collected
its own succession duties and corporation taxes; all of the other provinces have
left the collection of their taxes in the hands of the federal government.

The
period of the early 1960's also witnessed the multiplication of shared-cost programs
and the working out of the opting-out formula. Under this formula which Quebec
was the only province to fully use, extra abatements, equivalent to the federal
contribution in the other provinces, are also given. In 1966, the equalization
formula was revised to take into account a whole range of provincial revenues.
In the late 1960's, such equalization payments were equivalent to 50% of the revenues
of certain provinces. This proportion has tended to decrease since. In 1972, the
tax abatements granted to the provinces were as follows (Quebec's share is indicated
separately as it includes abatements resulting from the opting-out formula):

Tax
abatements granted to the provinces (1972)

Canada-Quebec

Quebec

Personal income
tax

28%

50%

Corporation tax

10

20

Succession duties

50

50

The war and post-war fiscal
agreements between the two levels of government have had several advantages. The
fiscal policies of the two levels of government were coordinated and a high degree
of economic stability was thus achieved; taxes were generally made uniform and,
eventually, the revenues of the provincial governments were somewhat equalized;
a major depression was averted as a result of the stabilizing policies of the
federal government. These stabilizing policies were successful because a large
share of the total government revenues was concentrated in the hands of the federal
government; citizens in the poorer provinces were assured a standard level of
services which they could not have otherwise afforded.

The
disadvantages were that the country functioned as if it was, more or less, a unitary
system, with many of the provinces relegated to the role of welfare recipients;
the tax renting agreements concentrated a large share of total government receipts
into the hands of the federal government thus making it impossible for the provinces
to help themselves; if a substantial amount of tax decentralization has occurred
over a long period of time, we are still far from the tax distribution of the
pre-war period. Evidence also points to the fact that the federal share of taxes
stopped decreasing since the early 1970's.

Distribution
of Governmental Revenues After Transfers Selected years, 1945-1972

Year

Federal

Provincial

Municipal

1945

70.6%

16.2%

13.2%

1950

61.2

22.4

16.4

1955

62.7

19.8

17.5

1960

52.8

23.9

23.3

1965

47.0

29.0

24.0

1970

40.7

35.3

24.0

1971

38.9

37.2

23.9

1972

40.1

36.3

23.6

The tax renting system led
to constant friction with Quebec. The province demanded that its fiscal autonomy
be respected. If, on the one end, the war and post-war measures adopted by the
federal government have had some impact on minimizing the effects of regional
and provincial disparities, on the other end these disparities continued to exist
as great as ever. All the usual indicators (personal income, share of gross national
product, growth rate, unemployment rate) point to the failure of the system to
eradicate the source of these disparities in the period of 1945 to 1977.
1) Federal policies encourage people to stay in poor areas thus contributing to
the perpetuation of economic problems in slow growth areas and 2) slow growth
areas have become so dependent on the federal government that the real decentralization
that Canadians seem to demand cannot be brought about without catastrophic effects
on such regions. Ultimately the solution seems to rest in shifting the emphasis
from welfare support to economic development. Such a system should help eradicate
disparities and restore some of the regions of Canada to their former pride and
prosperity.